‘Dumb’ vs. ‘smart’ investors

by Kamal Hassan

If you are raising money, you may encounter the phrases ‘smart’ and ‘dumb money’, as a way to describe different types of investors. As an entrepreneur, you may wonder: which is better for me. should I try to get smart or dumb money?

The first thing to keep in mind is that typically capital seems scarce. As an entrepreneur, you may not care who gives it to you, and you may want to take it where you can get it. So who cares. There are, however, a small subset of companies that are doing so well that investors want to throw money at them, in which case you can get picky. There are also a larger group of patient companies who may not need cash immediately (this is the best place to be), and who may feel that waiting to get the right investor is worth it.

So who is right for you?

“Smart money” is a term used by professional investors to describe themselves. These are people who invest for a living. They typically dictate the terms on a deal. They make sure they are looked after, including by getting a good valuation, and (even more important) good deal terms. They also (claim) to offer you the benefit of their expertise. This may include advice on how to better run your business, sitting on your board and making sure it does its job, opening the door to key customers or partnerships, and making sure any follow-on funding you need gets done smoothly and at good terms. Take the claims of expertise cautiously: the best ones do a great job of helping your business. Others can harm your business, with things degenerating into a fight for control rather than working together to support the business. So ask around for the reputation of the investor before you start, and try to make sure that you at a minimum get one that will do no harm – if not one of the (few) great ones.

You can group classical ‘smart money’ investors into VCs, who invest in around 1,000 new companies each year in the US (the most active venture capital market in the world), and angel groups, whose members invest in around 2,000 new companies each year in the US. In case you were wondering, there are about 6,000,000 new businesses started each year in the US. So, one out of every 2,000 business startups will receive ‘smart money’ investors.

“Dumb money” is a term used by professional investors to describe other investor types. The attitude is “we know what we are doing and we know how to help companies, people who don’t actively manage their investments and companies, i.e., who don’t invest the way we do, don’t know what they are doing”. The category includes three broad types:

  • the first is ‘angel investors’: people who could qualify to join an angel group but choose not to: often referred to as ‘superangels’ and ‘lone wolf angels’. Many are successful entrepreneurs who want to invest in other businesses (this was how I became an angel). They invest in around 60,000 companies each year. Your odds are 20 times better to get investment from these angels than they are from ‘smart money’ … and the odds have only improved to 1:100.
  • the second is ‘family offices’: these are people who are so wealthy that they hire people, whose job is to manage their money. I haven’t found good sources on the amount and scale of family office investment in the US: there are only on the order of 6,000 such groups. They are my personal favorite sort of investor: they are professional, helpful, yet don’t want to run your business. I don’t have good data on much investing they do: from personal experience they do very little investing, and the companies they do back they often back to the hilt: your odds of finding them may be similar or worse to other ‘angels’ (1:100)
  • the third group is what is disparagingly called ‘FFF: friends, family and fools’ by professional investors. This is your uncle Patel, your former boss or your dentist or doctor. Based on my best reading of the various stats out there, something like 30% of all private companies have at least some money from non-management, which means this group invests in 20 times more companies (by number) than every other investment source combined.

Such investors have wildly varying personal characteristics. Many of the following are likely to apply, though: they will often let you set the price and deal terms (and will simply say no or yes), your investment is likely to be a ‘fun’ and ‘can afford to lose’ investment for them, and they may not want a board seat or active involvement, they are just hoping you will pay off for them some day (they look at you like a lottery ticket). They are unlikely to try to take your company from you: they have a day job elsewhere. They will give you advice only when asked, rather than giving you the hard truths you need to hear. They will have random networks rather than a network cultivated to support small businesses.

These investors can be a pleasure to deal with if you as an entrepreneur are honest with them up front about the risks of the investment, and then make sure you keep them informed about your progress. They can also be a nightmare if you ‘take their money and run’, and then dread every Thanksgiving holiday when the subject of the investment is guaranteed to surface.

To sum up, both groups have their pluses or minuses. The best smart investors give valuable help. The worst ones get into a power struggle with you. Both write deal terms to protect themselves over you. Dumb investors will often give you money on better terms, with less hassle. The onus shifts to you to keep on top of them and keep them informed.

You are statistically more likely to raise money, in order, from (1) people you know (FFF) (1 in 3 chance), (2) individual angel investors/family offices (1 in 100 chance), and lastly (3) professional investors, i.e., angel groups or VCs (1 in 2,000 chance). So if you want money now, and don’t have a special reason to think you are a 1 in 2,000 company … focus your efforts on ‘dumb money’. How do you know for sure if you are a 1 in 2,000 company? The VCs will start calling you (it’s happened to me). Then you will really get to choose whose money you want!

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